More than a decade ago, after the burst of the original dot-com bubble, a frequent subject of complaints among investors and journalists was the proliferation of fuzzy “pro forma” financial metrics in companies’ reports to investors. Starting in about the late 1990s, many companies would routinely goose their profits by pretending lots of ordinary expenses didn’t exist, at least for the purposes of their press releases.
That’s how Enron Corp., for example, managed to show “recurring earnings” of $393 million for the third quarter of 2001 -- just as it was in the process of imploding. The figure, which didn’t fool anyone in the end, excluded more than a billion dollars of stuff that counted as expenses under U.S. generally accepted accounting principles.
Many companies still engage in this kind of nonsense in their quarterly earnings releases. At least nowadays, thanks to rules passed by the Securities and Exchange Commission in 2003, U.S.-listed companies usually must show how the figures can be reconciled to their actual results under prevailing accounting standards.
There’s one big exception that the SEC carved out for financial institutions, however, which brings me to the subject of my column today about the farce of banks’ so-called risk-weighted assets.
Deutsche Bank AG excluded an astounding 83 percent of its total assets last quarter when calculating its risk-weighted assets. Why would a bank want to minimize its assets, as opposed to its expenses? Because, as I explain in my column, this allows it to keep less capital on hand to meet regulatory requirements.
Deutsche Bank’s disclosures provide no way for investors to see how it got its figure. The bank, which trades on the New York Stock Exchange, wasn’t required to provide any reconciliation of its risk-weighted assets to the total assets on its balance sheet, which it prepares using international accounting standards. The risk-weighted calculations were based on the bank's own proprietary models.
The SEC said in 2003 that it allowed for the exception in response to requests from the banking industry. (Here are some comment letters cited by the SEC.) In short, if a given financial measure is required to be calculated and disclosed for regulatory purposes, then it doesn’t have to be reconciled to any of the standard numbers on a company’s financial statements. So risk-weighted assets don’t have to be reconciled to the total assets shown on a bank's balance sheet in accordance with U.S. or international accounting standards.
The banks like this, obviously. But for the public, there’s no transparency. The SEC should revoke this exemption.
(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter.)
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